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Unit 1 spm

  2. COURSE OBJECTIVE  To plan and manage projects at each stage of the software development life cycle (SDLC).  To learn about the activity planning and risk management principles.  To manage software projects and control software deliverables.  To develop skills to manage the various phases involved in project management and people management.  To deliver successful software projects that support organization‘s strategic goals.
  3. UNIT I PROJECT EVALUATION AND PROJECT PLANNING  Importance of Software Project Management  Activities - Methodologies  Categorization of Software Projects  Setting objectives  Management Principles & Management Control  Project portfolio Management  Cost-benefit evaluation technology  Risk evaluation  Strategic program Management  Stepwise Project Planning
  5. INTRODUCTION/ FUNDAMENTALS 5 What is a Project? Some dictionary definitions: “A specific plan or design” “A planned undertaking” “A large undertaking e.g. a public works scheme”
  6. 6 Characteristics of projects • • • • • • • • • • Non-routine tasks are involved Planning is required Specific objectives are to be met or a specific product is to be created The project has a predetermined time span Work is carried out for someone other than yourself Work involves several specialisms People are formed into a temporary work group to carry out the task Work is carried out in several phases The resources that are available for use on the project are constrained The project is large or complex
  7. 7 Software Projects versus other types of Projects • Invisibility – With physical artifacts, measuring progress is easy as it can be seen/ felt. However with Software, progress is not immediately visible. • Complexity – Software products are, generally, more complex than other engineering artifact of same value. • Conformity – Software developers have to conform to the requirement of human clients. It is not just that individuals can be inconsistent • Flexibility - It is easier to change/ modify software systems to meet changing organizational/ product requirement as compared to other engineering artifacts; it may not be possible to modify a physical artifact at all.
  8. What is Management • Planning – deciding what is to be done • Organizing – making arrangements • Staffing – selecting right people for the job etc. • Directing - giving instructions • Monitoring – checking on progress • Controlling – taking action to remedy hold-ups • Innovating – coming up with new solutions • Representing – liaising with clients, users, developers, suppliers and other stakeholders. 5
  9. The Management Spectrum Effective project management focuses on four P’s (in the order): The People: Stakeholders, the team leaders, and the software team • • Deals with the cultivation of motivated, highly skilled people and teams Includes recruiting, selection, performance management, training, compensation, career development, organization and work design, and team culture development The Problem/ Product: before a project can be planned • • • Its objectives and scope should be established; Alternative solutions should be considered; and Technical and management constraints should be identified. The process: a software process provides the framework from which a comprehensive plan for software development can be established. The project: Planning and controlling a software project is done for one primary reason…it is the only known way to manage complexity 6
  10. 10 • Software Project Management Software project management is aimed to ensure that the software is delivered on time, within budget and schedule constraints, and satisfies the requirements of the client • Management of software projects is different from other types of management because: – Software is not tangible – Software processes are relatively new and still “under trial” – Larger software projects are usually “one-off” projects – Computer technology evolves very rapidly
  11. Project Phases 11 • All projects are divided into phases • All phases together are known as the Project Life Cycle • Each phase is marked by completion of Deliverables • Identify the primary software project phases
  12. 7 Project Management Skills • Leadership • Communications • Problem Solving • Negotiating • Influencing the Organization • Mentoring • Process and technical expertise
  13. Software Project Management Management Project Management 13 Software Project Management
  14. Seven Core Project Phases as of SDLC 14
  15. Project Phases Also Known as. 15
  16. 14 Interactions / Stakeholders • As a PM, who do you interact with? – Internal to Project team – team members – External to project team but within the same organization - Project sponsor, Executives, Functional managers – External to both the project team and the organization – Customers, Contractors
  17. Purpose of Project Management • Ensure meeting the project objectives within the allocated schedule & budget – Communication – Meetings – Reviews – Authorization – Record Keeping – Monitoring (testing) – Interface Control • Not for assigning blame (usually)
  18. Module 1 - Introduction 16 5% 15% Project Life Cycle Planning Execution/Control Closing Percentages and graph refer to the amount of effort (people) In IT projects = 90-95% of cost! Definition | Analysis |Design|Build|Test|Accept| Implement| Operation 20% 60% INTRODUCTION/ FUNDAMENTALS Initiation or Concept
  19. 17 •Initiation – on the first stage, the necessity, feasibility, scope, time, budget and critical success factors of the project are defined along with the approach and methods to be used to deliver the required products and results. •Planning – this stage includes a detailed identification of all the project elements and matters including project team, specified allocation of project resources and timeline, assignments of project tasks, evaluation of risks, definition of criteria for quality and successful completion of each deliverable, etc. Project Life Cycle
  20. • Execution – this is the working phase where the project plan is implemented through practical actions that lead to successful project accomplishment. It is necessary to control performance and quality of all the required activities to know if they match the project’s requirements. • Closure – this stage identifies the project completion including testing, evaluation and formal acceptance of the final product by the customer, learning obtained from project experience, etc.
  21. Lifecycle Relationships 21
  22. Project vs. Program Management • What’s a ‘program’? • Mostly differences of scale • Often a number of related projects • Longer than projects • Definitions vary • Ex: Program Manager for MS Word 22
  23. 20 INTRODUCTION/ FUNDAMENTALS • The Triple Constraint of Projects On Time, Budget, Quality = Required Scope Time Cost Quality
  24. 21 Trade-off Triangle • Know which of these are fixed & variable for every project
  25. Problems with Software Projects Module 1 - Introduction 25 Manager’s Point of View: • • • • • • Poor estimates and plans Lack of quality standards and measures Lack of guidance about making organizational decisions Lack of techniques to make progress visible Poor role definition – who does what? Incorrect success criteria Members’ Point of View: • • • • Inadequate specification of work Management ignorance of IT Lack of knowledge of application area Lack of standards Contd/-
  26. Problems with Software Projects Module 1 - Introduction 26 • • • • • • • • • • • • • Lack of standards Lack of up-to-date documentation Preceding activities not completed on time – including late delivery of equipment Lack of communication between users and technicians Lack of communication leading to duplication of work Lack of commitment – especially when a project is tied to one person who then moves Narrow scope of technical expertise Changing statutory requirements Changing software environment Deadline pressure Lack of quality control Remote management Lack of training
  27. INTRODUCTION/ FUNDAMENTALS 27 Assignment 1 Q1. What do you understand by Need identification, Vision and Scope for a product? Search on internet to find sample vision and scope document, copy the headings in your notebook and be prepared to present in the class –Group Activity – one per group. Q2. What is the Vision Statement of ABES EC? What is the difference between Vision Statement and Quality Policy of an Organization? – Individual work.
  28. 2 Overview  Introduction to Step Wise Project Planning  Select Project  Identify Project Scope and Objectives  Identify Project Infrastructure  Analyze Project Characteristics  Identify Project Products and Activities  Estimate Effort for Each Activity  Identify Activity Risks  Allocate Resources  Review/Publicize Plan  Execute Plan/Lower Levels of Planning
  29. 3 Introduction to Project Planning  Project planning guides the execution of the project, coordinating the activities. facilitates better communication between the project stakeholders. provides a means of tracking and monitoring the progress. provides a detailed documentation regarding planning decisions.  Project planning is of significant importance for the success of the project. Careful planning helps prevent costly mistakes. Good planning is the key to meet the project objectives within defined time and budget.
  30. 4 Introduction to Project Planning  Many different techniques can be used for project planning.  This chapter introduces the Step Wise method.  An example to other methods is the PRINCE2 method. It is a set of project management standards that were originally sponsored by the Office of Government Commerce (OGC) for use on British governtment ICT and business change projects. The standarts are now also widely used on non- government projects in the UK.  Step Wise method is also compatible with PRINCE2. Step Wise covers only the planning stages of a project and not monitoring and control.
  31. 5 An Overview of Step Wise
  32. 6 An Outline of Step Wise Planning Activities
  33. 7 An Outline of Step Wise Planning Activities
  34. 8 An Outline of Step Wise Planning Activities
  35. 9 Step 0: Select Project  Called Step 0 because it is actually outside the main project planning steps.  While feasibility study suggests that there is a business case for the project, it would still need to be established that it should have priority over other projects.  This evaluation can be part of project portfolio management.
  36. 10  1.1. Identify objectives and practical measures of the effectiveness in meeting those objectives How do we know we are successful?  1.2: Establish a project authority Who is the boss?  1.3. Stakeholder analysis – identify all stakeholders in the project and their interests Who does what?  1.4. Modify objectives in the light of stakeholder analysis What shall we do for the commitment of stakeholders to the project?  1.5. Establish methods of communication with all parties How do we stay in touch and informed? Step 1: Identify Project Scope and Objectives
  37. 11 Step 2: Identify Project Infrastructure  2.1. Identify relationship between the project and strategic planning  2.2. Identify installation standards and procedures  2.3. Identify project team organization
  38. 1 2 Step 3: Analyze Project Characteristics  3.1. Distinguish the project as either objective- or product-driven  3.2. Analyze other project characteristics (including quality-based ones)  3.3. Identify high-level project risks  3.4. Take into account user requirements concerning implementation  3.5. Select development methodology and life- cycle approach  3.6. Review overall resource estimates
  39. 1 3 Step 4: Identify Project Products & Activities  4.1. Identify and describe project products (or deliverables)
  40. 1 4 Step 4: Identify Project Products & Activities  4.2. Document generic product flows
  41. 1 5 Step 4: Identify Project Products & Activities  4.3. Recognize product instances  4.4. Produce ideal activity network
  42. 1 6 Step 4: Identify Project Products & Activities  4.5. Modify the ideal to take into account need for stages and checkpoints Assumption of ideal activity network:  an activity will start as soon as the preceding ones upon which it depends have been completed. But we need to divide the project into stages and introducing checkpoint activities  to check that products of preceding activities are compatible. Milestones represent the completion of important stages of the project of which managers would want to take particular note.  Checkpoint activities are often useful milestones.
  43. 1 7 Step 5: Estimate Effort for Each Activity  5.1. Carry out bottom-up estimates Estimates for each activity is produced about  staff effort required  probable elapsed time  non-staff resources Elapsed time is different from effort!  Effort is the amount of work that needs to be done.  Elapsed time is the time between the start and end of a task.  5.2. Revise plan to create controllable activities
  44. 1 8 Step 6: Identify Activity Risks  6.1. Identify and quantify activity-based risks Look at each activity in turn and assess the risks to its successful outcome. The damage that each risk could cause and the likelyhood of its occurrence must be evaluated.  6.2. Plan risk reduction and contingency measures where appropriate Contingency plans specify action that is to be taken if a risk materializes.  6.3. Adjust overall plans and estimates to take account of risks
  45. 1 9 Step 7: Allocate Resources  7.1. Identify and allocate resources  7.2. Revise plans and estimates to take into account resource constraints
  46. 2 0 Step 8: Review/Publicize Plan  8.1. Review quality aspects of the project plan Each task should have quality criteria. These quality checks have to be passed before the activity can be “signed off” as completed.  8.2. Document plans and obtain agreement Plans should be carefully documented. All the parties to the project must understand and agree on the plan.
  47. 2 1 Steps 9/10: Execute Plan/Lower Levels of Planning  Once the project is under way, plans will need to be drawn up in greater detail for each activity as it becomes due.  Detailed planning of the later stages will need to be delayed because more information will be available nearer the start of the stage.  It is necessary to make provisional plans for the more distant tasks.
  48. 22  Any planning approach should have the following elements: the establishment of project objectives the analysis of the characteristics of the project the establishment of an infrastructure consisting of an appropriate organization and set of standards, methods and tools the identification of the products of the project and the activities needed to generate those products the allocation of resources to activities the establishment of quality controls  Project planning is an iterative process As the time approaches for particular activities to be carried out they should be replanned in more detail. Summary
  49. • Strategic Assessment • Technical Assessment • Cost Benefit Analysis • Cashflow Forecasting • Cost Benefit Evaluation techniques • Risk Evaluation
  50. PROJECT EVALUATION • Project evaluation is normally carried out in step 0 of stepwise • Project evaluation is a step by step process of collecting, recording and organizing information about – – – Project results short - term outputs (immediate results of activities or project deliverables) Long – term outputs (changes in behaviour , practice or policy resulting from the result.
  51. Why is project evaluation important: Project evaluation is important for answering the following questions- -what progress has been made? -were the desired outcomes achieved? Why? -whether the project can be refined to achieve better outcomes? -do the project results justify the project inputs? What are the challenges in monitoring and evaluation? -getting the commitment to do it. -establishing base lines at the beginning of the project. -identifying realistic quantitative and qualitative indicator. -finding the time to do it and stricking to it. -getting feedback from your stakeholders. -reporting back to your stakeholders.
  52. STRATEGIC ASSESSMENT WHAT IS STRATEGIC PLANNING? Strategic planning is defined as an organization’s process of defining its strategy , or direction and making decisions on allocating its resources to pursue this strategy, including its capital and people -it deals with: -what do we do? -for whom do we do it? -how do we excel?
  53. • STRATEGIC ASSESSMENT is the first criteria for project evaluation – For evaluating and managing the projects, the individual projects should be seen as components of a programme. Hence need to do programme management. Programme management: • D.C. Ferns defined “a programme as a group of projects that are managed in a co-ordinated way to gain benefits that would not be possible were the projects to be managed independently”. • A programme in this context is a “collection of projects that all contribute to the same overall organization goals”. • Effective programme management requires that there is a well defined programme goal and that all the organization’s projects are selected and tuned to contribure to this goal”
  54. Evaluating of project is depends on: – How it contributes to programme goal. – It is viability [ capability of developing or useful]. – Timing. – Resourcing. • For successful strategic assessment, there should be a strategic plan which defines: – – – – Organization’s objectives. Provides context for defining programme Provides context for defining programme goals. Provide context for accessing individual project.
  55. • In large organization, programme management is taken care by programme director and programme executive , rather than, project manager, who will be responsible for the strategic assessment of project. • Any potential software system will form part of the user organization’s overall information system and must be evaluated within the context of existing information system and the organization’s information strategy. • If a well – defined information system does not exist then the system development and the assessment of project proposals will be based on a more “piece meal approach”. • Piece meal approach is one in which each project being individually early in its life cycle.
  56. • Typical issues and questions to be considered during strategic assessment • Issue – 1: objectives: – How will the proposed system contribute to the organization’s stated objectives? How, for example, might it contribute to an increase in market share? • Issue – 2: is plan – How does the proposed system fit in to the IS plan? Which existing system (s) will it replace/interface with? How will it interact with systems proposed for the later development?
  57. • Issue – 3: organization structure: – What effect will the new system have on the existing departmental and organization structure? – For example, a new sales order processing system overlap existing sales and stock control functions? • Issue – 4: MIS: – What information will the system provide and at what levels in the organization? In what ways will it complement or enhance existing management information system? • Issue – 5: personnel: – In what way will the system proposed system affect manning levels and the existing employee skill base? What are the implications for the organization’s overall policy on staff development. • Issue – 6: image: – What, if any, will be the effect on customer’s attitudes towards the organization? Will the adoption of, say, automated system conflict with the objectives of providing a friendly service?
  58. • Portfolio management – Strategic and operational assessment carried by an organization on behalf of customer is called portfolio management [third party developers] – They make use of assessment of any proposed project themselves. – They ensure for consistency with the proposed strategic plan. – They proposed project will form part of a portfolio of ongoing and planned projects • Selection of projects must take account of possible effects on other projects in the portfolio( example: competition of resource) and the overall portfolio profile (example: specialization versus diversification).
  59. Technical assessment – It is the second criteria for evaluating the project. – Technical assessment of a proposed system evaluates functionality against available: • Hardware • Software Limitations – Nature of solutions produced by strategic information systems plan – Cost of solution. Hence undergoes cost-benefit analysis.
  60. Economic Assessment COST BENEFIT ANALYSIS • • • It is one of the important and common way of carrying “economic assessment” of a proposed information system. This is done by comparing the expected costs of development and operation of the system with its benefits. So it takes an account: • • • Expected cost of development of system Expected cost of operation of system Benefits obtained • Assessment is based on: Whether the estimated costs are executed by the estimated income. And by other benefits The standard way of evaluating economic benefits of any project is done by “cost benefit analysis” •
  61. • • Cost benefit analysis comprises of two steps: Step-1: identifying and estimating all of the costs and benefits of carrying out the project. Step-2: expressing these costs and benefits in common units. Step-1: • It includes • Development cost of system. • Operating cost of system. • Benefits obtained by system. – When new system is developed by the proposed system, then new system should reflect the above three as same as proposed system. Example: sales order processing system which gives benefit due to use of new system. •
  62. • Step-2: – – – Calculates net benefit. Net benefit = total benefit = total cost. (cost should be expressed in monetary terms). Three types of cost • Development costs: includes salary and other employment cost of staff involved. • Setup costs: includes the cost of implementation of system such as hardware, and also file conversion, recruitment and staff training. • Operational cost: cost require to operate system, after it is installed.
  63. • Three categories of benefits: 1) Direct benefits: directly obtained benefit by making use of/operating the system. Example: reduction of salary bills, through the introduction of a new , computerized system. 2) Assessable indirect benefits: these benefits are obtained due to updation / upgrading the performance of current system. It is also referred as “secondary benefits”. Example: “use of user – friendly screen”, which promotes reduction in errors, thus increases the benefit. 3) Intangible benefits: these benefits are longer term, difficult to quantify. It is also referred as “indirect benefits”. Example: enhanced job interest leads reduction of staff turnover, inturn leads lower recruitment costs.
  64. CASH FLOW FORCASTING It estimate overall cost and benefits of a product with respect to time. • • -ive cashflow during development stage. +ive cashflow during operating life. During development stage • • • • Staff wages Borrowing money from bank Paying interest to bank Payment of salaries Amount spent for installation, buying hw and sw Income is expected by 2 ways. • Payment on completion • Stage payment
  65. Cost Benefit Evaluation techniques
  66. Cost Benefit Evaluation techniques It consider • • the timing of the costs and benefits the benefits relative to the size of the investment Common method for comparing projects on the basic of their cash flow forecasting. • • • • • 1)Net profit 2)Payback Period 3)Return on investment 4)Net present Value 5)Internal rate of return
  67. Net profit • Net profit calculated by subtracting a company's total expenses from total income. showing what the company has earned (or lost) in a given period of time (usually one year). also called net income or net earnings. Net profit=total costs-total incomes
  68. • Calculate net profit. Year Project1 Project2 project3 0 -100000 -1,000,000 -120000 1 10,000 2,00000 30,000 2 10,000 2,00000 30,000 3 10,000 2,00000 30,000 4 20,000 2,00000 30,000 5 100000 3,00000 75,000
  69. • Calculate net profit (-ive total cost or total investment) Year Project1 Project2 project3 0 -100000 -1,000,000 -120000 1 10,000 2,00000 30,000 2 10,000 2,00000 30,000 3 10,000 2,00000 30,000 4 20,000 2,00000 30,000 5 100000 3,00000 75,000 Net profit 50,000 1,00,000 75,000
  70. Payback Period • The payback period is the time taken to recover the initial investment. Or • is the length of time required for cumulative incoming returns to equal the cumulative costs of an investment Advantages • • simple and easy to calculate. It is also a seriously flawed method of evaluating investments Disadvantages • • • • • It attaches no value to cashflows after the end of the payback period. It makes no adjustments for risk. It is not directly related to wealth maximisation as NPV is. It ignores the time value of money. The "cut off" period is arbitrary.
  71. • Calculate Payback Period Year Project1 Project2 project3 0 -100000 -1,000,000 -120000 1 10,000 2,00000 30,000 2 10,000 2,00000 30,000 3 10,000 2,00000 30,000 4 20,000 2,00000 30,000 5 100000 3,00000 75,000
  72. • Payback Period Project1 =10,000+10,000+10,000+20,000+1,00,000=1,50,000 Project 2=2,00,000+2,00,000+2,00,000+2,00,000+3,00,000=11,000,00 Project 3= 30,000+30,000+30,000+30,000 + 75,000 =1,95,000 It ignores any benefits that occur after the payback period and, therefore, does not measure profitability. It ignores the time value of money.
  73. RETURN ON INVESTMENT or ACCOUNTING RATE OF RETURN • It provides a way of comparing the net profitability to the investment required. Or A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments • • Disadvantages • • It takes no account of the timing of the cash flows. Rate of returns bears no relationship to the interest rates offered or changed by bank.
  74. RETURN ON INVESTMENT ROI =average annual profit total investment * 100 Average annual profit = net profit Total no. of years
  75. • Calculate ROI for project 1 Ans: Total investment =1,00,000 Net profit = 50,000 Total no. of year = 5 Average annual profit=50,000/5=10,000rs ROI= (10,000/1,00,000) *100 = 10%
  76. Ex1: • Calculate the ROI for the following projects and comment, which is the most worthwile. Investment Netprofit • Project1 150000 50000 • Project2 1,000000 1,00000 • Project3 450000 40,000 • The period of above project is 5 years.
  77. Ex2: There are two projects x and y. each project requires an investment of rs 20,000. you are required to rank these projects according to the pay back method from the following information. Year Project x Project y 1 1000 2000 2 2000 4000 3 4000 6000 4 5000 8000 5 8000 10000
  78. Net present value (NPV) • Discounted Cash Flow (DCF) is a cash flow summary adjusted to reflect the time value of money. DCF can be an important factor when evaluating or comparing investments, proposed actions, or purchases. Other things being equal, the action or investment with the larger DCF is the better decision. When discounted cash flow events in a cash flow stream are added together, the result is called the Net Present Value (NPV). • When the analysis concerns a series of cash inflows or outflows coming at different future times, the series is called a cash flow stream. Each future cash flow has its own value today (its own present value). The sum of these present values is the Net Present Value for the cash flow stream. • The size of the discounting effect depends on two things: the amount of time between now and each future payment (the number of discounting periods) and an interest rate called the Discount Rate.
  79. • • The example shows that: As the number of discounting periods between now and the cash arrival increases, the present value decreases. As the discount rate (interest rate) in the present value calculations increases, the present value decreases. •
  80. Applying discount factors Year Cash-flow Discount factor(discount rate 10%) Discounted cash flow 0 -100,000 1.0000 -100,000 1 10,000 0.9091 9,091 2 10,000 0.8264 8,264 3 10,000 0.7513 7,513 4 20,000 0.6830 13,660 5 100,000 0.6209 62,090 NPV 618 Click for An NPV of RM0 would be the same amount of profit would be generated as investing at 10%.
  81. Example: Comparing Competing Investments with NPV. • Consider two competing investments in computer equipment. Each calls for an initial cash outlay of $100, and each returns a total a $200 over the next 5 years making net gain of $100. But the timing of the returns is different, as shown in the table below (Case A and Case B), and therefore the present value of each years return is different. The sum of each investments present values is called the Discounted Cash flow (DCF) or Net Present Value (NPV). Using a 10% discount rate Timing Discount Rate(10%) CASEA CASE B Net Cash Flow Present Value Net Cash Flow Present Value Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00 Year 1 0.9091 $60.00 $54.54 $20.00 $18.18 Year 2 0.8264 $60.00 $49.59 $20.00 $16.52 Year 3 0.7513 $40.00 $30.05 $40.00 $30.05 Year 4 0.6830 $20.00 $13.70 $60.00 $41.10 Year 5 0.6209 $20.00 $12.42 $60.00 $37.27 Total A Net CF = $100.00 NPVA = $60.30 B Net CF =$100.00 B NPV =$43.12
  82. Ex 3:
  83. Solution
  84. Ex:4
  85. Ex : 5 Consider the following fictitious scenario and some questions related to it. The table below gives the estimated cash flow for three different projects
  86. Based on the above table, answer the following questions: 1 Calculate the net profit of each project. 2 Based on your answer to Question 1 above, which project would you select to develop? 3 Using the shortest payback method as discussed in Hughes and Cotterell, which project would you now select for development and why? 4 Calculate the Return on Investment (ROI) of each of these projects. 5 Based on your calculation of the ROI of each project in Question 4 above, which project would you select to develop? 6 Assume a discount rate of 12%. Calculate the Net Present Value (NPV) of each project. 7 Based on your calculation of each project’s NPV, which project would you now select for development? In general, what conclusion do you reach regarding the viability of these projects? (Base your answer on the NPVs of each project.)
  87. IRR (Internal Rate Return) • The IRR compares returns to costs by asking: "What is the discount rate that would give the cash flow stream a net present value of 0?" Timing Discount Rate(10%) CASE A CASE B Net Cash Flow Present Value Net Cash Flow Present Value Now 0 1 – $100.00 – $100.00 – $100.00 – $100.00 Year 1 0.9091 $60.00 $54.54 $20.00 $18.18 Year 2 0.8264 $60.00 $49.59 $20.00 $16.52 Year 3 0.7513 $40.00 $30.05 $40.00 $30.05 Year 4 0.6830 $20.00 $13.70 $60.00 $41.10 Year 5 0.6209 $20.00 $12.42 $60.00 $37.27 Total A Net CF = $100.00 NPVA = $60.30 B Net CF =$100.00 B NPV =$43.12
  88. • IRR asks a different question of the same two cash flow streams. Instead of proposing a discount rate and finding the NPV of each stream (as with NPV), IRR starts with the net cash flow streams and finds the interest rate (discount rate) that produces an NPV of zero for each. The easiest way to see how this solution is found is with a graphical summary:
  89. • These curves are based on the Case A and Case B cash flow figures in the table above. Here, however, we have used nine different interest rates, including 0.0 and 0.10, on up through 0.80. As you would expect, as the interest rate used for calculating NPV of the cash flow stream increases, the resulting NPV decreases. For Case A, an interest rate of 0.38 produces NPV = 0, whereas Case B NPV arrives at 0 with an interest rate of 0.22. • • • • Case A therefore has an IRR of 38%, Case B an IRR of 22%. IRR as the decision criterion, the one with the higher IRR is the better choice.
  90. Risk Evaluation
  91. Risk evaluation Risk evaluation is meant to decide whether to proceed with the project or not, and whether the project is meeting its objectives. Risk Occurs: • When the project exceed its original specification • Deviations from achieving it objectives and so on. Risk Identification and ranking Risk and Net Present Value • • For riskier projects could use higher discount rates Ex: Can add 2% for a Safe project or 5 % for a fairly risky one. Cost benefit Analysis Risk profile analysis Decision trees 4 6
  92. Risk Identification and ranking • • • Identify the risk and give priority. Could draw up draw a project risk matrix for each project to assess risks Project risk matrix used to identify and rank the risk of the project • Example of a project risk matrix 4 7
  93. Risk profile analysis • • • • This make use of “risk profiles” using sensitivity analysis. It compares the sensitivity of each factor of project profiles by varying parameters which affect the project cost benefits. Eg: Vary the original estimates of risk plus or minus 5% and re-calculate the expected cost benefits.
  94. • • • • P1 depart far from p2,have large variation P3 have much profitable than expected All three projects have the same expected profit Compare to p2 , p1 is less risky.
  95. Decision trees • • • Identify over risky projects Choose best from risk Take suitable course of action Decision tree of analysis risks helps us to  Extend the existing system  increase sales  improve the management information •   Replace the existing system Not replacing system leads in loss Replace it immediately will be expensive.
  96. Decision trees • The expected value of Extending system= (0.8*75,000)- (0.2*100,000)=Rs.40,000 • The expected value of Replacing system= (0.2*250,000)- (0.8*50,000)=Rs.10,000  Therefore, organization should choose the option of extending the existing system. 5 1